Torrid Holdings Inc. Q2 FY2022 Earnings Call

Greetings. Welcome to Torrid Holdings Inc. Second Quarter Fiscal 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now like to turn the conference over to your host Mr. Adams. You may begin.

Good afternoon, everyone. Thank you for joining Torrid’s call today to discuss second quarter financial results for 2022, which we released this afternoon and can be found on our website at investors.torrid.com. With me today on the call are Lisa Harper, Chief Executive Officer of Torrid; and Tanner MacDiarmid, Interim Chief Financial Officer. Before we get started, I would like to remind you of the company’s Safe Harbor language, which I’m sure you’re familiar with. Management may make forward-looking statements, including guidance and underlying assumptions. Forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. For a further discussion of risks related to our business, see our filings with the SEC. This call will contain non-GAAP financial measures, such as adjusted EBITDA and adjusted EBITDA margin. Reconciliations to these non-GAAP measures to the most comparable GAAP measures are included in the earnings release furnished to the SEC and available on our website. With that, I will now turn the call over to Lisa.

Thanks, Vince. Good afternoon, everyone. And thanks for joining us for the discussion of our second quarter results. Before I start, I'd like to take a moment to acknowledge and thank the team at Torrid that's been so resilient as we've navigated many important initiatives over the last quarter. I've been back at Torrid for four months now, and I'm continually impressed by the passion and dedication of our employees. During the second quarter, we made progress against the priorities that we laid out on our last call. And we remain focused on making the necessary improvements to drive long-term sustainable growth. As a reminder, my top three priorities for the business are; number one, to enhance promotional and marketing strategies to better balance margin and sales growth. Number two, to drive growth across multiple opportunities, and number three, to develop a more efficient and effective organization by realigning resources. On today's call, I'll update you on our second quarter results and provide details around the progress we've made around each of these priorities. Starting with our second quarter results, net sales grew 2% to $341 million, which was in line with the high end of our updated guidance. Although we have a very loyal customer base at Torrid, we are not immune to the macro and industry-wide challenges that have impacted consumer sentiment and customer demand. Our store experience did decrease in year-over-year traffic as customers dealt with higher fuel prices and overall inflationary pressures that impacted demand. We were pleased, however, to see an increase in web traffic along with higher conversion rates. We also rolled out our planned upgrades to our distribution center during the quarter, which created temporarily unanticipated headwinds in our fulfillment process. We were able to successfully complete the upgrades in July, and the fulfillment center is now operational, with orders shipping within our service level agreement. Customers have noticed the improvement in delivery time, and we are receiving positive feedback across our social channels on the changes. Gross margin rate was 34.9% for the quarter, and adjusted EBITDA came in at $52 million. During the quarter, we focused on clearing through seasonal inventory, which led to higher promotions and markdowns that impacted our gross margin rate. We will continue to focus on clearance through the first part of the third quarter. We have bought receipts to be more balanced in the back half of the year. In addition to managing our inventory and upgrading the capacity at our distribution center, we also successfully launched a new ERP system during the quarter. These are enormous accomplishments, and I'm proud of the progress that we've made. This brings me to the three main priorities. Our first priority is to refine our marketing and promotional strategies. We continue to believe that there's an opportunity to reduce site-wide promotions and to realign our marketing and merchandising strategy. As we move into the back half of the year, we'll be testing more category-focused promotions based on price elasticity, with the goal of reducing discounts on styles with the strongest natural demand. We're implementing these changes on site, and we started providing percentage discounts based on inventory and demand, instead of blanket promotions. This is the first step in refining our promotional cadence and driving margin improvements. In marketing, we're focused on capturing customers through our dressing room experiences in stores, where our most valuable customers discover and fall in love with the brand. Despite the pressure in the macro environment, stores remain our number one acquisition channel, and we know that customers acquired through the stores spend 25% more in their first year compared to those acquired on the web. We also have the strategic advantage of a profitable store fleet that offers an unparalleled shopping and fitting room experience with new customers who go on to engage with Torrid across both channels. In addition to driving customers into our stores, we've been refining our online marketing strategy, and we were able to deliver improved efficiencies in our spend while still building a healthy customer file through a focus on both acquisition and retention. During the second quarter, we began targeting lapsed customers more aggressively through email campaigns and other digital channels. We saw a 600 basis point comp improvement in reactivated customers versus the first-quarter trend. We will continue to reevaluate our marketing spend throughout the year and reallocate to where we see the most opportunity to acquire and retain customers. This brings me to my second priority, which is driving growth across categories. We have exciting launches coming in the third quarter that we believe will help accelerate our business. Our modern workwear aligned Studio by Torrid launched today, and it's the biggest launch in our brand's history. We're excited to bring our customers an elevated assortment through a refined comfort-based offering as she prepares for her return to work. We've also seen success with our woven pants, sweaters, and dresses, and will be offering more fashion in these categories in the back half of the year. While product remains a competitive strength, we do believe our assortment has been too reliant on basics, and we are shifting our merchandising strategy to offer a better balance between fashion and basic styles. Additionally, we will focus our assortment on more wear-to-work products with a celebratory use. We are also adding more newness, color, and excitement to our upcoming fall assortment and elevating our marketing approach through better storytelling around our product and fit across all channels. These efforts kick off starting with our Studio launch, and continue into the back half of the year with holiday. Within Curve, we're opening eight Curve test stores between now and the end of the year. We still believe in the long-term growth potential of Curve, and we have plans to innovate our assortment through an evolution in our bra and panty businesses. My third priority is to improve our organizational structure. As promised last quarter, we've made two key hires that I believe will be instrumental in helping us drive growth and scale in the business. Tim Martin, our new Chief Operating Officer and Chief Financial Officer, is a seasoned retail executive who brings more than 25 years of experience across a variety of consumer-facing companies. He has experience in the public markets and will be critical to unifying the operational and financial aspects of our business. Hyon Park recently joined as our Chief Technology Officer reporting to Tim, and he will lead the team in building an integrated technology platform. Hyon also brings 25 years of information technology and consulting experience across retail and direct to consumer companies and will be pivotal in helping to build more robust technology and digital capabilities. With respect to infrastructure, we have made significant progress across the organization. The changes to the distribution center have doubled our capacity and provided more room to scale. As part of our efforts to drive efficiency, we negotiated a new private label credit card agreement that includes plans to streamline the cardholder experience through better marketing and technical enhancements. The upgrades we made to our Oracle ERP system will also allow for enhancements to our website and better integration of data across the organization. In closing, we believe that the changes we are making to the business will position us for long-term healthy growth. We expect to see the benefits of these changes as we move through the year and into fiscal 2023. And with that, I'd like to turn the call over to Tanner to provide more detailed financials on the quarter and our updated guidance.

Thank you, Lisa. And good afternoon, everyone. We will begin with a detailed discussion of our financial results followed by an update on our outlook for the rest of the year. Starting with the second quarter results, net sales grew 2% to $341 million compared to $333 million last year, and comparable sales in the quarter were up 1%. This is on top of the 30% comp in the second quarter of last year. As Lisa discussed, we experienced challenges related to the macro environment that impacted our expected demand this past quarter. We also made upgrades to our distribution platform to increase capacity for eCommerce order fulfillment, which caused temporary shipping disruptions that we corrected by the end of the quarter. Our fulfillment center is now fully operational, and we are seeing improved throughput and capacity that will limit delivery backlogs moving forward. Gross profit for the second quarter was $119 million or 34.9% of net sales. This compares to $150 million, or 45% of net sales in the second quarter of last year. Approximately 600 basis points of the decline was due to higher discounts and promotions to clear inventory. The remainder of the decline was inflationary and related to increased product and transportation costs, partially offset by price increases. As Lisa mentioned, we plan on higher promotional activity through the first part of the third quarter to clear through inventory. Selling general and administrative expenses in the quarter were $66 million compared to $179 million for the second quarter of the prior year. As a percentage of sales, SG&A decreased to 19.3% from 53.8% compared to the second quarter of last year, due to lower share-based compensation and higher private label credit card income. The decrease in share-based compensation expense during the quarter was due to the remeasurement of our equity value during the second quarter of the prior year as part of our IPO. Additionally, we've renegotiated our new private label credit card agreement that resulted in additional card income and drove a 230 basis points decrease in SG&A as a percentage of net sales. Excluding share-based compensation and private label credit card income, our SG&A increased by 180 basis points versus the prior year, primarily caused by inflationary pressures, including higher wages. Marketing expenses in the quarter came in at $14 million compared to $11 million in the second quarter of last year. As a percentage of sales, marketing expense increased approximately 80 basis points compared to 3.2% in the second quarter of last year. During the quarter, we focused on driving improved marketing optimization through a shift of our digital spend into customer reactivation efforts, where we expect a greater return on investment. This shift in strategy, along with a rationalization of marketing tests in the quarter drove efficiencies in our spend. We will continue to invest in marketing where we see the most opportunity, including spend to drive new, existing, and lapsed customers into our highly profitable store environment. Turning to profitability, net income for the quarter was $23 million, or $0.22 per share, versus net income of $39 million, or $0.35 per share for the same period last year. We had no adjustment to net income in the second quarter of 2022, but for comparison purposes, adjusted net income last year was $39 million or $0.36 per share. In addition to GAAP measures, we believe that adjusted EBITDA and adjusted net income are important measures that we use to evaluate and manage our business. Adjusted EBITDA came in at $52 million or 15.3% of net sales, compared to $87 million or 26% of net sales in the second quarter of 2021. Now turning to the balance sheet. Our cash and cash equivalents at the end of the quarter totaled $23 million. Total liquidity at the end of the first quarter, including available credit was $162 million. During the quarter, we repurchased $9 million of common shares outstanding and had $45 million remaining under our stock repurchase program at the end of the quarter. Total debt at the end of the quarter was $335 million, compared to $341 million in the second quarter of 2021. Our net debt to adjusted EBITDA was 1.7 times at quarter end. Inventory at the end of the quarter was $181 million, compared to $110 million in the prior year. Excluding in transit, total inventory at the end of Q2 was up 40% to pre-pandemic 2019. This compared to a 32% sales growth and increased product costs over that same time period. As we progress through the quarter, we remain focused on selling through excess inventory. With our current plan sales and receipts, we remain comfortable with our inventory levels for the remainder of the year. We opened five Torrid stores and closed three stores in the second quarter, and plan to open approximately 34 stores for the year, including eight close stores. Turning to the outlook. Given the uncertainty in the macro environment, we expect the second half of the year to follow similar demand trends that we've seen in the first half. For the third quarter, we projected net sales to be between $290 million and $305 million for the quarter, and adjusted EBITDA to be between $32 million and $38 million. This outlook assumes our gross margin rate will continue to be pressured as we clear through inventory. For the full year, we're forecasting sales to be between $1.26 billion and $1.3 billion. For adjusted EBITDA, we are projecting between $160 million and $175 million. As a result of higher interest rates on our term loan, we expect interest expense to be approximately $8 million in the third quarter. Capital expenditures are projected to be between $30 million and $33 million for fiscal 2022, reflecting infrastructure investments and our previously mentioned 34 new store openings. We're also planning to close approximately nine stores this year. Finally, this is my last call as Interim CFO of Torrid. I am incredibly honored to have served as CFO of such an inspiring company. I want to thank Lisa and the entire team for their support. To ensure a smooth transition for Tim, I will continue to stay on with Torrid as a consultant.

Our first question comes from Mark Altschwager with Baird. Please go ahead with your question.

Good afternoon. Thanks for taking my question. So just starting out with the sales guidance. The guidance for the back half of the year doesn't appear to incorporate much improvement in trend from where the business has been tracking recently. But at the same time, shipping disruptions have been corrected. And you do sound pretty excited about the product flow for the back half. So I'm hoping you can just walk us through your thinking a bit more on what the back half of the year might look like?

Yes, I think just given the macroeconomic environment and while we are a bit conservative with the forecast in the back half of the year, we're projecting the back half to be on trend with what we've seen in the first half of the year. And that's relatively flat to last year. That being said, we are optimistic about all the things that Lisa has mentioned in her commentary on product and operations and our ability to execute.

Thank you. Regarding the pricing and promotional strategies, many in the industry seem to be gearing up for more aggressive promotions in the latter half of the year. Could you share your approach to handling this and if the overall promotional landscape has influenced your plans to test any new strategies? Thank you.

Sure. I think it's very difficult to separate the pressure of clearing through excess inventory that's been rampant in the sector for the first half, particularly the second quarter from those impacts of the macro environment. As I've said before, the focus here is really not just pulling back on overall promotions, but in right-sizing the promotion to the specific product category, or even to the SKU level, so that our messaging can be up to percentage off instead of a flat percentage off, which has been our tradition, particularly in the web channel. So, whereas historically, we've been up to 20-25, 30-35 off on the web, now the messaging will switch to up to 35 off and we'll determine the actual promotional discount on the items based on the demand of those items. The same modeling that we do to price our markdowns based on price elasticity and availability will be used for our overall day-in and day-out promotions. I do feel like over time as we bring in more and more newness in product categories based on what the customers have been asking for that as we adjust our inventory levels, as we have done for the back half of this year, we'll be able to moderate that over time. But we're certainly not advocating eliminating promotions or canceling promotions. We're just about optimizing them to achieve our gross margin results.

Thank you, and best of luck.

Our next question comes from the line of Kimberly Greenberger with Morgan Stanley. Please proceed with your question.

Hi, this is Amanda on for Kimberly. Can you please just speak to your monthly sales trends during the quarter as well as anything you're seeing quarter-to-date?

In the second quarter, I think we were very consistent with what we've heard from the market, which was on June 30, when the average gas price in the U.S. reached $5, that definitely had an impact and direct correlation to overall traffic. At the same time, we accelerated promotions to deal with the overall inventory situation. That created a combination of effects that was difficult to isolate. As we mentioned in our comments, we did have positive traffic trends online, but not in stores. However, we did see good conversion trends across the board in the second quarter. Regarding third quarter results, I won't get into specifics at this point, but we're currently focused on clearing through these goods as we get past the Labor Day holiday and into fall. We have seen similar trends as we dealt with clearance and promotion of our excess inventory. We expect to see improvements in both traffic and conversion on both channels as we move towards the back half of the quarter. Again, we've reinforced a generally conservative approach to the back half of the year, and we're not looking for dramatic improvement in either traffic or conversion, but we do have very strong product and healthy inventory levels where we reduced purchases by about 7% in dollars for the second half and about loads teams and units. We feel that we have an opportunity to drive traffic and conversion with a healthier margin as we move to the back half of the year, but we're not baking in a lot of that upside yet.

Great. Thank you so much. And then just one more for me. We've seen in our store checks that your assortment feels like it's broadening out in its appeal. And I know you just mentioned that you've launched your expansion to workwear, so can you talk about how you're thinking about your merchandise strategy overall in the long term? Should we expect a meaningful shift there?

Did you say broadening out in the appeal?

Yes, that's correct.

Okay. Yes, I think that once again, Torrid is in a market position that we can provide the customer with everything in their closet. We focus on a 34-year-old customer in terms of mindset, which encompasses a variety of psychographics and leads to a younger and more fashion-oriented assortment. But we're very focused on launches like Studio that gives her a lot of flexibility and alternatives in her wardrobe. So, it is a broader assortment because she doesn't have choices in the marketplace. We know every new category that we've added, every concept added, has very strong appeal, because we can provide everything in her closet, not changing the focus of the customer demographic or psychographic perspective, but giving her more options and choices to make within the assortment.

Great. Thank you so much.

Does that answer your question?

Yes, definitely.

Our next question comes from the line of Oliver Chen with Cowen. Please proceed with your question.

Hi, thank you. Looking ahead in terms of the assortment and changes you're making, how would you prioritize the biggest opportunities? And how are you broadly thinking about pricing and addressing retailer concerns to ensure that you're offering a compelling value? In the near term, as we understand the clearance and the inventory you need to get through, how many more quarters will that take? And what are the right guardrails to minimize impact to long-term brand equity in terms of offering discounts? Thank you.

Sure, to answer the last part of your question first, I would say that we're really comfortable with the mix of inventory between clearance and regular price online, and we're at 2019 levels in stores for clearance and regular price. We think that it is getting progressively better. As I've mentioned, the inventory purchased in the back half of the year is down 7% year over year. We feel like this quarter is the last quarter where we'll be dealing with this excess inventory issue, and we expect improved conditions as we progress into the back half of the year, particularly in the third and fourth quarters. I didn't note the first part of your question, although…

Pricing promotion.

Thanks. So, we're not really increasing prices anymore in the back half of the year compared to what we did in the first half. We evaluate pricing on an item-by-item basis considering market value and what we ascertain to be the customer value against comparable pricing in the marketplace. Regarding promotions, we feel that our recently launched Studio line and other new offerings allow for a better mix of dressy and casual basics, giving us more breadth to cautiously pull back on the depth of the discount. Still, we recognize that the macro challenge is promotionally heavy. I would say that fundamentally, the customer is very dedicated to Torrid and consistently shops the latest offerings on our website. We receive positive feedback as soon as we introduce new looks and categories, and we're starting to see that as we enter the later part of the third quarter into the fourth quarter. So, in summary, we're market-driven and ensuring that we deliver value while innovating product mix based on demand.

Okay, and as you consider what’s happening in the business and the changes and opportunities you're pursuing, what about store count and the potential for growing the store base? Is it still the right time for that opportunity? We'd love to hear your thoughts on that. Lastly, Curve has always been a big focus. We'd love your thoughts on Torrid Curve, key priorities, and what you see next for that assortment. Thank you.

Fantastic. In terms of stores, our store fleet is very profitable. It provides a compelling economic model in customer acquisition and lifetime value, with the quality of the customer being exceptional. As I mentioned in my comments, most of our new customers come through the store channel, and they tend to spend 25% more in the first year. They also become Omni-channel customers quite rapidly. Therefore, it's strategically significant for us to review our approach toward store openings and expansion as we move forward. It is critical for our business as it enhances customer experience. As for Curve, I strongly believe in its growth opportunity. We are, as noted, opening eight stores with the first one launching in early October. This will complete by the first week of December. Our focus is on providing a broader range of product categories while appealing to a wider customer base. We aim to attract a slightly younger customer through this concept. Additionally, we’re strategizing on how we can encourage customers to graduate from Curve to Torrid. We're currently performing vital analysis and planning to ensure that our tests and learning are well-supported for long-term growth in the intimate sector of the business. I'm still quite optimistic about this, and it's at the top of our list for strategic investment moving forward.

Thanks so much, Lisa. Best regards.

Our next question comes from Dana Telsey with the Telsey Advisory Group. Please go ahead with your question.

Good afternoon, everyone. Lisa, as you think about the buckets underneath the margin, whether it's product costs, transportation costs, or marketing expenses, how do you envision the back half of the year? Is there a difference between the first half and the second half? And as for the workwear aligned products that you introduced, what has the initial reaction been? What percentage of the launch is meeting expectations? Does sales velocity differ by region or by channel? Thank you.

To answer your second question first, the launch today saw that the top eight of the ten items sold so far this morning were in that line. That’s a good sign, but it’s still too early to determine regional or channel distribution. As for margins, there isn't a vast difference in terms of transportation costs year over year or costs of goods – that's pretty much established at this point. The biggest opportunity for margin improvement in the second half of the year will come from reducing the amount of excess inventory needing clearance, and from the desirability of the product allowing us to adjust our promotional stance and depth based on that. The back half of this year does not reflect major fluctuations in the costs of goods or freight. We are cautiously optimistic for the fourth quarter but are remaining conservative in our expectations overall.

And one other quick thing as we approach the holiday season, are there any shifts you're making in terms of marketing or how you're thinking about the upcoming holiday this year?

I would just say broadly, our storytelling and marketing, our product launches are a priority. We're introducing more products in the back half of this year than we have in recent times, and we've historically received positive responses. We have new pants in the Studio line, some little black dresses, and additional dressy and sexy options that we haven’t presented for some time. We're also focused on retaining and reactivating customers in our marketing initiatives. We want to encourage our customers to return to the store and engage in the fitting room experience, a critical aspect of our retail strategy. This is something we're enhancing through digital channels and overall brand marketing. Does that answer your question?

Yes, it does. Thank you. Great.

And we have reached the end of the question and answer session. I'll now turn the call back over to Lisa Harper for closing remarks.

Great. I do want to highlight something I didn't answer in the questions, the significant improvements we made to the infrastructure in the quarter, doubling the capacity in the distribution center and delivering on SLAs along with the relaunch of the new ERP, which is no small feat and was accomplished by the team in the second quarter. I want to congratulate them on that. I also want to thank Tanner for his leadership and guidance as we've moved through these last four months. I've really enjoyed working with you and look forward to continuing that experience. We look forward to talking to all of you again in the third quarter call very soon. Take care.

This concludes today's conference, and you may disconnect your line at this time. Thank you for your participation.